Let's assume that bond market participants suddenly expect the Fed to substantially increase the money supply.
a. Assuming no threat of inflation, how would bond price be affected by this expectation?
b. Assuming that inflation may result, how would bond prices by affected?
c. Given your answers to (a) and (b) explain why expectations of the Fed's increase in the money supply may sometimes cause bond market participants to disagree about how bond prices will be affected
Whenever the Fed increases money supply, it does so by buying bonds in the open market. Buying bonds by the Fed will bid up the bonds prices and thus resulting to a lower interest rate given that there is no ...
The solution examines the effect to bond prices as Fed's increase in the money supply.